What is an S corporation shareholders agreement?

Most S corporations with multiple shareholders should have a written shareholders' agreement in effect for a simple reason. An S corporation shareholders' agreement reduces the chance and diminishes the costs of a shareholder intentionally or unintentionally doing something that terminates the S corporation's "S" status.

Fortunately, an S corporation shareholder's agreement doesn't have to be that complicated. You'll want to discuss three issues with your attorney:

S Corporation Shareholder's Agreement Issue #1: One of the things that should appear in an S corporation shareholders' agreement is a list of actions that individual S corporation shareholders agree not to take. For example, an S corporation shareholders' agreement should document shareholder promises not to sell stock to an ineligible S corporation shareholder (since such a sale would terminate the S corp status).

S Corporation's Shareholder's Agreement Issue #2: Another common shareholders agreement provision is an indemnity clause. The indemnity clause in a shareholder agreement might say that if a shareholder does do something that damages an S corporation or it shareholders, that shareholder promises to pay the financial consequences. In other words, an S corporation shareholder might be on the hook to pay the extra (and possibly very significant) taxes that would accrue because of any accidental or intentional termination of the S corporation's "S" status.

S Corporation Shareholder's Agreement Issue #3: The final common component of an S corporation shareholders agreement is a promise to assist with any remedies required in case something does happen to foul up the S corporation's "S" status. Here's why. In general, any inadvertent or accidental violation of the S corporation illegibility rules won't matter too much if the S corporation immediately corrects the problem. For example, if the S corporation finds that one of its shareholders is ineligible shareholder but that shareholder's stock is immediately transferred to an eligible shareholder, the ineligible shareholder's brief ownership would not necessary cause the S corp status to terminate. The shareholders of an S corporation should, therefore, agree to assist and cooperate with an S corporation and with other S corporation shareholders in effecting these sorts of remedies.

Note: A well drafted operating agreement for a limited liability company--if the limited liability company always anticipated becoming an S Corporation--may contain language that works as an S corporation shareholders agreement. Similarly, a well-constructed set of corporate by-laws may also contain language that works as an S corporation shareholders agreement if the attorney drafting the corporate by-laws knew that an S election was imminent.

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